The two appeals by the assessee are directed against separate orders of the Commissioner of Income-tax(Appeals) IV, Hyderabad, both dated 29.2.2012 for the assessment years 2007-08 and 2008-09. Assessee has also filed applications seeking stay of recovery of outstanding demand for those two years, till the hearing and disposal of those appeals. Similarly, the appeal of the Revenue is directed against the order of the CIT(A) Guntur, dated 28.2.2011 for the assessment year 2006-07. Since all these matters involve a common issue, these appeals are clubbed and heard together and are being disposed off with this common order for the sake of convenience.

2. In the appeal of the Revenue for the assessment year 2006-07, ITA No.803/Hyd/2011, the grievance of the Revenue is against the direction of the CIT(A) to treat the income arising out of the assessee/s transactions of buying and selling shares as long term capital gains. Similarly, in the assessee’s appeals for the assessment years 2007-08 and 2008-09, the common grievance of the assessee is against the direction of the CIT(A) to treat the income arising out of the assessee’s activities in buying and selling of shares as income from business, instead of as long term capital gains exempt from income-tax, as claimed by the assessee.

3. Brief facts of the case are that the assessee is engaged in the business of investment and dealing in securities. Assessee treated the income from the share transactions as capital gains and thereby claimed exemption under S.10(38) of the Income-tax Act. Besides, the assessee has shown income from short term capital gains as taxable at special rates. For the assessment year 2006-07, the CIT(A) has given a direction to the assessing officer to treat the income from out of buying and selling of shares as capital gains, and also directed granting of exemption of the same from tax under S.10(38) of the Act. Against this direction of the CIT(A), Revenue is in appeal before us.

4. However, for the assessment years 2007-08 and 2008-09, the CIT(A) has held that the income arising out of buying and selling of shares by the assessee should be assessed as income from business, and accordingly upheld the view taken by the assessing officer in this behalf for those years. Aggrieved by this finding of the CIT(A), assessee is in appeal.

5. The learned counsel for the assessee submitted that the assessee has not employed any person to carry on any business for the years under appeal. He further submitted that the assessee has not borrowed any funds from outside agency in the years under consideration for the purchase of the shares. It is further submitted that the assessee has in fact not purchased any shares during the years under appeal, and has only dealt in the shares already purchased and brought forwarded from earlier years. He also relied on the Circular of the CBDT No.4 of 2007 dated 15th June, 2007, which reads as under-

The Income Tax Act, 1961 makes a distinction between a capital asset and a trading asset.

2. Capital asset is defined in Section 2(14) of the Act. Long-term capital assets and gains are dealt with under Section 2(29A) and Section 2(29B). Short-term capital assets and gains are dealt with under Section 2(42A) and Section 2(42B).

4. The Central Board of Direct Taxes (CBDT) through Instruction No.1827 dated August 31, 1989 had brought to the notice of the assessing officers that there is a distinction between shares held as investment (capital asset) and shares held as stock-in-trade (trading asset). In the light of a number of judicial decisions pronounced after the issue of the above instructions, it is proposed to update the above instructions for the information of assessees as well as for guidance of the assessing officers.

5. In the case of Commissioner of Income Tax (Central), Calcutta Vs Associated Industrial Development Company (P) Ltd (82 ITR 586), the Supreme Court observed that:

Whether a particular holding of shares is by way of investment or forms part of the stock-in-trade is a matter which is within the knowledge of the assessee who holds the shares and it should, in normal circumstances, be in a position to produce evidence from its records as to whether it has maintained any distinction between those shares which are its stock-in-trade and those which are held by way of investment.

The High Court, in our opinion, made a mistake in observing whether transactions of sale and purchase of shares were trading transactions or whether these were in the nature of investment was a question of law. This was a mixed question of law and fact.

7. The principles laid down by the Supreme Court in the above two cases afford adequate guidance to the assessing officers.

8. The Authority for Advance Rulings (AAR) (288 ITR 641), referring to the decisions of the Supreme Court in several cases, has culled out the following principles :-

(i) Where a company purchases and sells shares, it must be shown that they were held as stock-in-trade and that existence of the power to purchase and sell shares in the memorandum of association is not decisive of the nature of transaction;

(ii) the substantial nature of transactions, the manner of maintaining books of accounts, the magnitude of purchases and sales and the ratio between purchases and sales and the holding would furnish a good guide to determine the nature of transactions;

(iii) ordinarily the purchase and sale of shares with the motive of earning a profit, would result in the transaction being in the nature of trade/adventure in the nature of trade; but where the object of the investment in shares of a company is to derive income by way of dividend etc. then the profits accruing by change in such investment (by sale of shares) will yield capital gain and not revenue receipt.

9. Dealing with the above three principles, the AAR has observed in the case of Fidelity group as under:-

We shall revert to the aforementioned principles. The first principle requires us to ascertain whether the purchase of shares by a FII in exercise of the power in the memorandum of association/trust deed was as stockin-trade as the mere existence of the power to purchase and sell shares will not by itself be decisive of the nature of transaction. We have to verify as to how the shares were valued/held in the books of account i.e. whether they were valued as stock-in-trade at the end of the financial year for the purpose of arriving at business income or held as investment in capital assets. The second principle furnishes a guide for determining the nature of transaction by verifying whether there are substantial transactions, their magnitude, etc., maintenance of books of account and finding the ratio between purchases and sales. It will not be out of place to mention that regulation 18 of the SEBI Regulations enjoins upon every FII to keep and maintain books of account containing true and fair accounts relating to remittance of initial corpus of buying and selling and realizing capital gains on investments and accounts of remittance to India for investment in India and realizing capital gains on investment from such remittances. The third principle suggests that ordinarily purchases and sales of shares with the motive of realizing profit would lead to inference of trade/adventure in the nature of trade; where the object of the investment in shares of companies is to derive income by way of dividends etc., the transactions of purchases and sales of shares would yield capital gains and not business profits.

10. CBDT also wishes to emphasise that it is possible for a tax payer to have two portfolios, i.e., an investment portfolio comprising of securities which are to be treated as capital assets and a trading portfolio comprising of stock-in-trade which are to be treated as trading assets. Where an assessee has two portfolios, the assessee may have income under both heads i.e., capital gains as well as business income.

11. Assessing officers are advised that the above principles should guide them in determining whether, in a given case, the shares are held by the assessee as investment (and therefore giving rise to capital gains) or as stock-in-trade (and therefore giving rise to business profits). The assessing officers are further advised that no single principle would be decisive and the total effect of all the principles should be considered to determine whether, in a given case, the shares are held by the assessee as investment or stock-in-trade.

Further, he submitted that the assessee never treated its shares as stock in trade and it always treated the same as investment in the books of accounts and disclosed the income therefrom as income from investment. They learned authorized representative relied on the decision of Mumbai Bench of the Tribunal in the case of Hitesh Satishchandra Doshi v. Jt. CIT [2011] 46 SOT 336 for assessment years 2003-04 and 2006-07 respectively and others, wherein the Mumbai Bench of the Tribunal after referring in detail to the case-law on the point, observing that the nature of income received on sale of shares depends on the facts and circumstances of each case, held that the assessee in that case held the shares as investment and the income on the sale of the same cannot be treated as business income. He submitted that the ratio of the said decision clearly applies to the facts of the present case.

6. On the other hand, the Learned Departmental Representative submitted that the assessee has consistently engaged in the business of buying and selling of shares and it cannot be said that the assessee has only made investments in shares and has not carried any business. He relied on the decision of the Tribunal in the case of Spectra Shares Scrips [ITA No748/Hyd/2011 for the assessment year 2006-07 dated 5th August, 2011], wherein it has been held as under-

“Assessee company, having carried on the activity of buying and selling of shares in a systematic and regular manner with high frequency and volumes, repetitive purchases and sales of the same scrips throughout the year, it has to be held that it was engaged in trading in shares to earn profits and not buying shares for the purpose of investments and, therefore, income earned by the assessee falls under the head ‘profit and gains of business or profession’ and not ‘capital gains’.”

7. We heard both the parties and perused materials on record. The contention of the assessee is that it always treated the shares ass investment, and there is no business activity whatsoever carried on by the assessee with reference to shares. He further submitted that the principle of consistency has to be followed and there is no purchase made during the years under appeal, and all that the assessee has dealt with are in the shares brought forward from earlier years.

8. Coming to the facts of the present case, we consider the facts relating to the assessment year 2008-09, as the facts for all the three years are similar. For the assessment year 2008-09, the figures are as follows-

9. Against the above position of income and expenditure, assessee declared business income of Rs.1.56 lakhs and long term capital gains of Rs.10.80 cores and short term capital gains of Rs.20 lakhs. During the assessment year 2008-09, assessee dealt in the shares of 49 companies on which assessee declared long term capital gains and also dealt in shares of 20 companies and declared short term capital gains and volume of transactions relating to these gains is multiply large. Assessee stated before us that it has sold only out of opening balance of shares and not purchased any shares. Against this statement, we find that the assessee purchased shares of City Union Bank in September/October, 2007 and also purchased shares of First Leasing Company during the period April to July, 2007. Assessee also purchased the shares of Allahabad Bank in the month of July, 2007. Assessee has also purchased the shares of Himalaya International in the month of September, 2007. Similarly, assessee purchased shares of ICSIs India Ltd. and GMR Infrastructure during the months of January and February, 2008. It is also observed that from the statement of purchase and sale of shares that the assessee purchased the shares of Gulf Oil Corporation, R.Com, Royal Arcade Hotel, Viceroy Hotel, GP Associates, which were bought and sold within short time. Similarly in the case of JM Small and Midcap Mutual Fund, there is frequent buying and selling activities carried on by the assessee.

10. Now the question before us whether the assessee carried on the investment activity or business activity. On the other hand, the question is when the assessee classified the shares in the books as investments, whether really they are ‘investment’ or ‘stock in trade’. One of the relevant tests for determining whether it is in the nature of fixed asset or constitutes stock in trade of the assessee’s business. Fixed asset is what the owner turns to profit keeping the asset in his own possession, stock in trade is what he makes profit of by parting with it and letting it change masters. If the expenditure is made for acquiring or bringing into existence an asset or advantage for the enduring benefit of the business it is properly attributable to capital. If, on the other hand, it is made not for running the business of working it with a view to produce profits it is relatable to stock in trade. In determining the question whether after acquiring the shares, the assessee dealt with it as an investor or carried on business with it treating it as its stock-in trade or as a trading asset, what is relevant is that, if the case falls within the former category, receipts by way of sale of such shares will be capital receipts but if it falls within the latter the receipts will be trading receipts and profits therefrom business income. The intention with which such operation is carried on is relevant. If a owner of an investment realizes it and obtained a greater price for it than the price at which he originally acquired, if the enhanced value obtained from the realisation or conversion of securities may be profit from business. The distinction whether the investment transaction is a mere realization of the investment or an act done for making profit depends on the question whether excess was an enhancement of the value for realising the shares by a gain in an operation of making profit. If the transaction is in the ordinarily lien of the assessee’s business, there would hardly be any difficulty in concluding it to be a trading transaction, but where it is not, the fact must be properly assessed to determine whether it is in the nature of trade. The surplus realized on the sale of share would be capital, if the assessee an ordinary investor realising his holding, but it would be revenue if he deals with them as a trader. if the assessee is an ordinary investor, the income arising out of sale of shares is capital gain. On the other hand, if he trades in shares in regular manner, it is income from business. If an individual invests in shares for the purposes of earning dividend, he is not carrying on a business. If the assessee is holding shares as investment and sold it due to change of circumstances and earns profits, that profit is nothing but capital gain. Whether a purchase is made with an intention of resale and gain to earn profit, such income has to be treated as income from business.

11. While deciding whether the sale of shares is income from business or income from capital gain, one has to go by the following criteria, as held by the jurisdictional High Court in the case of PVS Raju v. Addl. CIT [2012] 340 ITR 75.

(a) The frequency of buying and selling of shares by the appellants were high;

(b) The period of holding was less;

(c) The quantum of turnover was on account of frequency of transactions, and not because of huge investment;

(d) The intention of the assessee to make quick profits on a huge turnover;

(e) No. of scrips shares held for fewer days;

(f) Whether engaged in dealing in these came scrips frequently;

(g) Intention of the assessee in buying shares is not to derivce income by way of dividend on such shares, but to earn profits on the sale of the shares;

(h) Whether the assessees had indulged in multiple transactions of large quantities with high periodicity. These periodic transactions selecting the time of entry and exit in each scrip, called for regular direction and management which would indicate that it was in the nature of trade;

(i) Repeated transactions, coupled with the subsequent conduct of the assessee to re-enter the same scrip or some other scrip, in order to take advantage of market fluctuations lent the flavour of trade to such transactions;

(j) The assessees were purchasing and selling the same scrips repeatedly, and were switching from one scrip to another;

(k) Mere classification of these share transactions as investment in the assessee’s books of accounts was not conclusive;

(l) The intention of the assessees at the time of purchase was only to sell the shares immediately after purchase;

(m) Frequency of purchase and sale of shares showed that the assessee never intended to keep these shares as investment; and

(o) It is only for the purpose of claming benefit of lower rate of tax, under Section 111A of the Act, that they had claimed certain shares to be investment, though these transactions were only in the nature of trade.

12. In the light of the above parameters and the decision of the jurisdictional High Court, on perusal of the statements incorporated by the assessing officer in the assessment order for the assessment year 2008-09, we find that the assessee has made several transactions of purchase of shares during the relevant year under consideration, and if there high volume, frequency and regularity of the activity carried on by the assessee in a systematic manner, it would partake the character of business activities carried on by the assessee in shares, and it cannot be said that the assessee has merely made investments in shares. Further, evidence brought on record shows that the assessee is carrying on both portfolios, viz. investment as well as business and for arriving at proper conclusion, the assessee has to furnish the relevant data for arriving at the nature of the relevant transactions, and the treatment given by the assessee in its books of account cannot be conclusive and the assessing officer has to see the real intention of the assessee in holding the relevant shares. The Assessee is also directed to furnish the details of shares held as investment and as stock in trade. On furnishing the entire data by the assessee, the Assessing Officer has to redetermine the income relating to each category of shares as business income or income from capital gains as the case may be, in conformity with Circular No.4 of 2007 dated 15.6.2007

13. In the result, both the appeals of the assessee for the assessment years 2007-08 an 2008-09 as well as the only appeal of the Revenue for assessment year 2006-07, are partly allowed for statistical purposes.

S.A.No.88/Hyd/2012

(in ITA No.452/Hyd/2012)

: Assessment year 2008-09

S.A.No.89/Hyd/2012

(in ITA No.453/Hyd/2012)

: Assessment year 2007-08

14. Since the very appeals of the assessee, giving rise to these stay applications have been disposed off in the foregoing paras, these applications for stay have become infructuous. They are accordingly dismissed.

15. To sum up, assessee’s appeals ITA Nos.452 and 453/Hyd/2012 as well as Revenue’s appeal ITA No.803/Hyd/2011 are allowed for statistical purposes, and both the Stay Applications of the assessee, being SA Nos.88 and 89/Hyd/2012, being infructuous, are dismissed.